Gold price: six reasons it slumped – and why it could stay low

Precious warning: Gold won’t be the only bubble to burst
July 23, 2015
March 23, 2018
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Gold price: six reasons it slumped – and why it could stay low

Gold price: six reasons it slumped – and why it could stay low

The gold price mounted a modest recovery yesterday following a sharp fall on Monday, but after closing below $1,100 for the first time in five years it is still hovering around this key threshold.

Analsts once predicted that gold prices would surge to $5,000 an ounce, but now many are saying that the precious metal could fall back through the $1,000 mark before the end of the year – and a slump into three figures could well trigger more falls.

Investors are beginning to take notice. Listed funds tracking the metal, which have been growing in popularity, saw the biggest outflow in two years on Friday, The Times reports. So what is driving the recent slump and is it likely to continue?

1. The strength of the US dollar

The US dollar has been gaining in value on the back of consistently positive data on the economy, which spells bad news for gold. As the Daily Telegraph notes, the value of the greenback typically has an inverse relationship with commodities.

Why? Like other commodities, gold is priced in dollars on international markets. This means that when the dollar rises investors have less buying power and commodities become more expensive, “muting demand and sending commodity prices lower”, the paper says.

2. The strength of the US dollar, part 2

But that isn’t the only reason that gold sinks with the dollar surges. The Economist suggests that the declining gold price is also a product of investors re-evaluating the real price of the metal in response to currency movements.

Essentially, if the dollar increases so does the nominal value of any asset quoted in dollars. But if this runs counter to investors’ perception of the market, they are likely to sell to ensure they aren’t caught out later.

3. Interest rate rise

Another factor emanating from the US is the recent talk of an interest rate rise. The Federal Reserve has been dropping strong hints that it may increase the base rate from 0.25 per cent sooner rather than later, and possibly this year. That will diminish the attraction of non-yielding assets.

Since gold provides neither a dividend nor an income, ther is an opportunity cost of holding the asset. That may be worth paying in bad times, when interest rates are low and the gold price is likely to be rising. When markets are improving, interest rates are rising and returns are increasing, that opportunity cost starts to pinch.

4. China

Not all the factors driving down the gold price originate in China: The Times points to China as another source of gold-sapping news – and, more specifically, to data showing that the country, which has designs on making its own Renminbi a reserve currency, has not been buying up gold in the quantities many have anticipated.

China’s gold reserves were up 57 per cent, but this was about half what was expected. As a share of total reserves, China’s holdings were actually in decline. Chinese acquisitiveness was one of the key assumptions underpinning the market in recent years, so this constitutes a major hiccup.

5. Less bad news

Greece has stepped back from the abyss – at least for now. The global economy seems to be trundling along and Western countries are seeing a return to growth. An apocalypse predicted by many, which would have scared investors into assets such as gold, has not happened.

6. Technical trades

This last point is one often missed in analyses of any sharp market fall. Many trades are now executed on an automated basis, the Telegraph says, with software which is designed to buy or sell when a price hits a given high or low level to manage risk in big portfolios.

Gold has reached the sort of low where the ‘stop-loss’ trades kick in, further fuelling a sell-off. The irony is that these programmes are designed to limit risk exposure and losses when in reality they often exaggerate market swings and increase nominal losses.

Will the slide continue?

There certainly seems to be a consensus that gold is not going rebound strongly any time soon. Some think the inflation-adjusted price for gold is even lower than $1,000, so it’s not out of the question that prices could continue to fall.

But if the macroeconomic picture were to change and become more negative, or China were to start buying in the way analysts have been predicting, attitudes to gold would probably change quite quickly.